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May 16, 2022

Stocks [or horses] aren’t cheap and popular at the same time.

-Anonymous

On August 21, 2021, on the turf of Ellis Park, Rich Strike a chestnut colt with a white blaze and two white socks on his hind legs, made his thoroughbred racing debut. Unfortunately, he did not strike or make anyone rich. In that first race, he broke late, was never a factor, and finished last.

A few weeks later [second race] the colt was dropped into a claiming race at Churchill Downs (site of the Kentucky Derby). Claiming races are an interesting aspect of thoroughbred racing designed to match similar quality and value horses together. The same price is set for each horse, typically half the purse and a trainer can purchase any horse in the race for the specified price. Eric Reed made a claim of $30,000 on Rich Strike before the race on behalf of Richard Dawson. Rich Strike broke slowly before he made a strong move on the turn to take the lead, winning by 17 ¼ lengths.

A few months and several races later, Rich Strike and his contingent were qualified as an alternate for the Kentucky Derby. Reed received the call thirty seconds before the cutoff that they would be running the Derby.

Sonny Leon [jockey] and Rich Strike were in the last stall of the starting gate. He broke well from the outside position and settled into the back of the pack where he was in eighteenth place after the first half-mile, 17 lengths behind the leaders. He started his move on the final turn while weaving through traffic, first shifting out four horses wide of the rail and then back towards the rail. In the stretch, he was checked briefly by a tiring horse but again found racing room and launched a sustained drive to the inside of Epicenter. He drew clear in the final strides to win by three-quarters of a length.1 A shocked Reed collapsed in the paddock. It happened so quickly that even the announcer did not acknowledge Rich Strike until he was at the finish, “Rich Strike is coming up on the inside, the longest shot has won the Kentucky Derby.”

An unproven, relatively unknown colt was purchased a few months ago for $30,000 and then won the biggest contest in horse racing against 80:1 odds. Comparatively, some of the wealthiest families in the world have spent billions in pursuit of the same trophy. Safe to say that Rich Strike was a value investment.

Beginning late last year, about the same time Rich Strike began his rise, value companies began to outperform growth companies. The big growth names have dominated the headlines and the indexes for over a decade. Something we have discussed before… the major indexes are cap-weighted. Larger market cap (stock price X shares outstanding) companies tend to dominate the returns of the indexes – up and down.

Growth companies and value companies can most simply be differentiated in generalities.

Dividends

Generally, value companies payout dividends with excess profits while growth companies tend to reinvest profits into more growth – research and development and expansion into new markets.

Valuations

Typically, growth companies trade at a higher value relative to their current earnings (P/E) because their earnings are anticipated to increase significantly in the future. This higher valuation today is pricing in some portion of those future cash flows.

Sectors

Value companies will most consistently be found in the financial, healthcare, industrial, and energy sectors while growth companies will usually be in the technology, discretionary, and communication services sectors.3

The shift from growth to value stocks is, in part, related to their different sensitivities to interest rates. This difference is related to the timing of the underlying cash flows. For growth companies, it is expected that a large fraction of their cash flow will occur in the future. Pricing for future cash flows must be discounted utilizing a current interest rate, as interest rates rise, a bigger discount is placed on those future cash flows. By contrast, well-established value firms have a track record of regularly generating positive cash flows now – less interest rate sensitivity.3

These recent fluctuations are normal and to be excepted as the markets and economy work through this shift in economic policy. As always, we continue to review and adjust as needed.
Please give me a call to discuss horse racing, growth versus value, or anything else on your mind.

-DC


1Long-shot Rich Strike. Sourced from – https://www.cnn.com/2022/05/07/sport/kentucky-derby-winner-rich-strike/index.html
2Value vs Growth: A Brief Historical View. Sourced from – https://www.nasdaq.com/articles/value-vs-growth%3A-a-brief-historical-view-2021-05-06
3Growth vs. Value Stock Investing. Sourced from – https://www.nerdwallet.com/article/investing/value-vs-growth-investing-styles